By Greg Arthur and Andrew Smith, Mellor Olsson
Property settlements can be difficult in themselves to resolve without the added complexity of taking into account tax issues which make the task of advisors even more difficult.
Our tax laws are constantly changing and there is a necessity for all practitioners to be aware of the tax issues that relate to the area in which they practise.
In recent times there have been some developments in taxation law which should be relevant or of interest to family law practitioners. Both result from ATO activity.
On 30 July 2014, the ATO released Taxation Ruling TR 2014/5, (“the Ruling”) which reverses the Commissioner’s previously held position that distributions of property or money from a private company as a consequence of family law proceedings will be treated as a deemed dividend being paid from the company to the recipient of the distribution under Division 7A of the Income Tax Assessment Act 1936 (“ITAA1936”). The end result is that now in many cases the recipient of a distribution of money or property from a private company as part of a family law property split will be subject to additional income tax.
The Ruling signals a significant departure in the ATO’s prior stance on the operation of Division 7A and matrimonial proceedings. Prior to the Ruling being issued, parties had frequently relied upon section 109J of the ITAA1936 which had enabled the parties to avoid Division 7A consequences.
Section 109J allows payments from private companies to associates to be considered as discharging an obligation… to pay money, rather than a distribution of profits from the company, provided that the company itself was obliged to make the payment as directed by an order made under section 79 of the Family Law Act 1979 (Cth) (“FLA”). This in turn exempts the payments from the operation of Division 7A. The ATO’s former position enabled separating couples to unwind corporate structures and assets without incurring further taxation under Division 7A (in the form of a deemed dividend to the recipient party).
The ATO’s revised stance on the application of Division 7A to matrimonial proceedings is premised on what appears to be a revised interpretation of section 109J.
In particular, the ATO now state in the Ruling that payments made under matrimonial proceedings fail the second limb of section 109J, which requires that the payment not be more than would have been required to discharge the obligation had the private company and the entity been dealing with each other at arm’s length.
At first glance this would appear counterintuitive, given that most would assume that parties to family law proceedings are a classic example of parties dealing at arm’s length.
The ATO’s response to this assertion is that the payment which was made must be measured against an “alternative hypothesis” in determining whether parties are dealing at arm’s length, which would in their view result in parties to matrimonial proceedings failing the second limb of the test (although interestingly, there does not appear to be anything in the legislation or available case law to support this approach).
As a result of the ruling, from 1 August 2014 any payments or transfers of property made from a private company to a departing spouse will be treated as deemed dividends and the departing spouse will be required to remit tax accordingly. This will be the case irrespective of whether the family law proceedings commenced prior to 1 August 2014. Where non-cash property is transferred, the dividend will be equal to the market value of the property transferred.
There will now be a need in many cases to restructure family law property settlements involving redistributions of private company assets going forward to accommodate for the ATO’s revised position.
There may be some potential ways to overcome or at least reduce the impact of the Ruling but these need to be considered in the light of particular circumstances to the parties and in conjunction with the parties’ tax advisors.
It is obvious to say that parties to matrimonial proceedings and their advisers must now take appropriate measures to ensure that the objectives of the parties to the matrimonial are achieved in the most tax-effective manner possible. This new Ruling adds another issue that the parties and their advisers will need to consider.
The Federal Court recently denied the Commissioner's request for access to documents that were part of family law proceedings for use in a tax case. This judgment comes in contrast to the Family Court decision of FCT v Darling earlier this year, in which the ATO’s application to obtain access to a family law file was successful.
The family law proceedings involved a dispute concerning property and rights concerning a child of the parties’ former marriage. The Commissioner sought only documents relating to the property dispute, and did not seek access to any documentation relating to the child.
The Commissioner sought to access the file in order to determine:
After considering the matter, the Federal Court said the exercise of discretion must involve weighing the likelihood of the Family Law file disclosing to the Commissioner anything of any real utility against the interest in preserving the confidential and personal nature of the documents contained in the file. The Court said it accepted the former husband’s submission that there was likely to be substantial practical difficulty in separating documents dealing with issues that might be of relevance to the Commissioner from those which disclose information touching upon the interests and concerns of the child.
The Court distinguished the decision in FCT v Darling partly based on the fact that the party to the family law proceedings was not himself a party to the tax proceedings .
The Court concluded that the utility in the Commissioner gaining access to the documents was outweighed by the public interest in confidentiality of Family Law proceedings, stating:
“While the Commissioner has submitted, and it is necessarily the case, that it is pure speculation to surmise that the Family Law file does not contain relevant information, the reverse is necessarily also true. It is pure speculation on the Commissioner’s part to surmise that the file might contain some relevant information. In that regard, I consider that there is force in Mr Lindholm’s submission that the very nature of the issues in the present proceeding, compared to the nature of the issues in the Family Law proceeding, make it improbable that the file will yield any information of real additional utility.”
The decision serves as a reminder that the ATO has an interest in financial and tax matters revealed in non-tax court proceedings involving taxpayers it may be investigating or auditing. The wide range of the powers afforded to the Commissioner mean that he may in some circumstances have recourse to information revealed in other such cases.
For more information contact Greg Arthur or Andrew Smith at Mellor Olsson:
Greg Arthur, Partner
08 8414 3422
Andrew Smith, Solicitor
08 8414 3549
or visit www.mellorolsson.com.au